AJALLP

Revocable trust vs. Irrevocable trust - A perspective of Indian Trust Act

FEMA

About the Author:

CA Dhruv Shah is Partner at Ambavat Jain & Associates LLP. He heads the service vertical offering consultancy to family offices on cross border tax and regulatory matters.

Opening Note:

India is currently on an unprecedented growth trajectory. It is one of the leading countries as far as success stories of new age startups and tech driven businesses is concerned. The Indian stock exchanges have also started gaining traction and are becoming one of the most sought-after destinations for initial public offerings of successful businesses.

With this, we are seeing a continuous rise in the number high net worth individuals in India. These individuals are constantly in search of a structure to ensure complete ring fencing of their family wealth. Thus, we are observing a growing trend of such family offices setting up private family trusts.

For helping such individuals understand the basic nuances of a private family trust and to help professionals offering services in this space, we are sharing our insights on the concept of how to classify whether a trust is a revocable trust or an irrevocable trust.

To keep brevity, as part of this article, we are only focusing on the concept from the perspective of the Indian Trust Act, 1882.

Brief note on the Indian Trust Act, 1882:

Before we delve deep into the subject matter of this particular article, it would be worthwhile to note a few basic points about the Indian Trust Act.

The Indian Trust Act was enacted in the year 1882. This act lays down the legal framework for creation, operation and termination of a private trust. In fact, the introductory statement of this act reads as “an act to define and amend the law relating to private trust and trustees.” Thus, one can construe that this act is only relevant for the study of private trust. It cannot be referred to for study in relation to public trust.

As part of this article, we are studying the classification of a private family trust and thus we would be referring to various provisions of the Indian Trust Act.

Introduction:

While setting up or dealing with any private trust, as a first step, it is important to ascertain whether the trust has been set up as a revocable trust or an irrevocable trust. This classification has important implications arising in the hands of all the parties to the trust during various stages of life cycle of the trust.

Further, this classification also has important implications that arise on the trust and various parties of the trust while computing the tax liability under the Indian Income-tax Act, 1961. The definition and test for classifying a trust into revocable trust or an irrevocable trust under the provisions of the Income-tax is much wider and different when compared to the Indian Trust Act.

As part of this article, we are not delving into the subject of classification of the trust under the income tax. We will be restricting our study only to the provisions of Indian Trust Act.

Implications of classification into revocable or irrevocable:

Before we delve into the finer aspects of how to classify a trust as a revocable trust or an irrevocable trust as per the provisions of the Indian trust act, it would be worthwhile to understand certain practical implications that arise on a trust either getting classified as a revocable trust or an irrevocable trust.

This would help the readers to appreciate the importance of why this study of classification is required in the first place.

As discussed earlier, one of the key reasons of why HNI family would set up a private family trust is to ring fence their family assets. Day in and day out, during business, the entrepreneur takes multiple risks. Though such risks are calculated ones, still one would have to consider the possibility of any risk backfiring whereby a huge liability would end up on the entrepreneur. Apart from the business risks, the entrepreneur also faces various regulatory risks. Thus, ring fencing of wealth is of paramount importance in today’s world.

The extent to which objective of ring fencing can be achieved via a private family trust depends on whether the trust has been set up as a revocable trust or an irrevocable trust. In a revocable trust, as the author of the trust continues to have the power to terminate the trust by taking back the asset, so it does not offer complete ring fencing. Here, if any liability comes up on the author of the trust, then the Regulator will have the right to proceed against the trust to recover the amount of liability to the extent of its revocability.

However, under an irrevocable trust, there is no such power vested in the hands of the author. In other words, the author has completely transferred the control and ownership of the asset to the trustee. So, in an eventuality of a liability arising on the author of the trust, there would be no question of revoking the trust and taking back the ownership. Thus, an irrevocable trust would offer complete protection to the wealth thereby ensuring complete ring fencing.

Apart from the objective of ring fencing, practically the decision of whether to set up a revocable trust or an irrevocable trust would also be important from the perspective of:

How much control does the author of the trust wishes to have on the asset even after settling it in the trust?
Whether the author of the trust is completely clear on his succession plan at this stage of his life? Or would he like to keep an option open to terminate the succession plan by taking back the ownership of the asset?
Whether estate duty or inheritance tax (as and when it would be introduced in India) will be applicable on an asset that has been settled under a revocable trust?

With the above brief discussion, the readers would now be able to appreciate the importance of classifying a trust into a revocable trust or an irrevocable trust.

General meaning of the term revocable and irrevocable:

The term revocable is an adjective. In other words, it can be used to give an attribute to a noun. In our case “trust” is a noun. The term revocable, being an adjective, can be used before the word “trust” to assign an attribute to the trust. In simple English, the term attribute would mean a quality or a feature.

Thus, the term revocable when used before the term trust helps to explain a quality or a feature of the trust. Let us try and see the meanings of the term “revocable” under various dictionaries:

As per www.vocabulary.com, the term revocable means rescindable or voidable. In other words, it would mean that revocable means something that is capable of being cancelled.
As per www.merriam-webster.com, the term revocable means capable of being revoked. The term revoke means to annul by recalling or taking back. In other words, revocable would mean something that is capable of being terminated by recalling or taking back.

Looking at the above, one can construe that a revocable trust would be something that is capable of being terminated or cancelled by either recalling or taking back the asset that was settled in the trust while creating it.

Irrevocable trust would consequently mean a private trust which is not a revocable trust. In other words, it would mean a trust that is not capable of either being terminated or cancelled by virtue of recalling or taking back the asset that was settled in the trust while creating it.

Meaning of the term revocable and irrevocable as per Indian Trust Act:

The terms “revocable trust” or an “irrevocable trust” are not specifically defined under any provisions of the Indian Trust Act.

Section 78 of the Indian Trust Act deals with the situations in which a private trust can be revoked. A deep reading of section 78 would help us understand the eventualities or conditions in which a trust can be classified to be a revocable trust.

There is no other section that deals with an irrevocable trust. Thus, we can construe that unless a trust is not getting classified as a revocable trust, then it would automatically be classified as an irrevocable trust.

Considering the above, we can conclude that as far as the Indian Trust Act is concerned, one has to study the provisions of section 78 in order to classify a trust either as a revocable trust or an irrevocable trust.

Coverage of section 78:

Section 78 can be broadly divided into two parts. The first part deals with testamentary trust, in other words a trust created by action of a Will. The second part deals with non-testamentary trust, in other words a trust that is created otherwise by way of action of a Will.

While beginning part of section 78 briefly touches upon the situation in which the testamentary trust can be revoked. It thereafter moves on to deal with the situations in which a non-testamentary trust can be revoked. The second part of section 78 that deals with non-testamentary trust lays down three different situations under which a trust can be revoked.

We will comprehensively study section 78 in the subsequent paragraphs.

Testamentary trusts:

The first part of section 78 deals with testamentary trust. The relevant extract is reiterated as under:

“A trust created by will may be revoked at the pleasure of the testator”

As per the above provision, we can construe that a testamentary trust can be revoked as per the wishes and pleasures of the testator. A testator is nothing but the person who has written his Will and has formed the trust by way of action of his Will.

During the lifetime of the testator, one can say that the testamentary trust would always be classified as a revocable trust. Reason being - the testator always has the power to revoke the trust as per his wish or pleasure.

This part of section 78 does not require any express reservation of power of revocation with the testator. Section 78 contemplates that the testator inherently always has this power to revoke the trust at any point in his lifetime as per his wishes and pleasures.

To summarize - a testamentary trust will always get classified as a revocable trust during the lifetime of the testator. Once the testator leaves for the heavenly abode, the trust would automatically get classified as an irrevocable trust.

Non-testamentary trusts:

Section 78 of the Indian Trust Act lays down three situations under which a non-testamentary trust can be revoked. These three situations are laid down as clauses a, b and c of section 78. Let us first study clause (a) and clause (c), thereafter we will move on to study clause (b) in detail.

Clause (a):

Clause (a) covers a situation in which there is a trust where all the beneficiaries are competent to contract, and they unanimously give their consent for revocation of the trust. This clause by default gives powers to all the beneficiaries who are competent to contract to revoke the trust at any point of time. However, provided this power is exercised during the lifetime of the settlor.

Once the settlor has left for heavenly abode, thereafter the powers in the hands of the beneficiaries under this clause (a) becomes redundant and inactionable. Consequently, one can say that after the lifetime of the settlor, the trust would perpetually become an irrevocable trust as far as clause (a) of section 78 is concerned.

As per this clause, there does not need to be any express reservation of such powers in the hands of the beneficiaries.

If we were to consider this clause for determining whether a trust is a revocable trust or an irrevocable trust, then every non-testamentary private trust would get classified as a revocable trust. However, this cannot be the intention of the law. That is why in general parlance when we need to classify whether a non-testamentary trust is a revocable or an irrevocable trust, reference to clause (a) of section 78 should not be drawn.

Clause (c):

Clause (c) is only applicable in the case of a trust that has been settled for the limited purpose of payment of debts of the author of the trust.

Thus, clause (c) would not offer any guidance on how to classify a trust into a revocable trust or an irrevocable trust as far as the general-purpose private family trusts are concerned.

Analysis of clause (b) of section 78:

Clause (b) of section 78 is important for our current discussion as it gives powers to the author of the trust to revoke the trust at any given point in time. For this reason, while classifying a trust into revocable or an irrevocable trust for general purposes reference to clause (b) is drawn.

Clause (b) of section 78 reads as under:

“Section 78 - Revocation of trust— A trust created by will may be revoked at the pleasure of the testator. A trust otherwise created can be revoked only—

…

(b) where the trust has been declared by a non-testamentary instrument or by word of mouth—in exercise of a power of revocation expressly reserved to the author of the trust;

…”

The important text of the clause has been highlighted above. The terms “expressly reserved” indicates that the power of revocation is not inherently vested in the hands of the author of the trust. To vest such powers in hands of the author of the trust, there must be an express reservation or mention or delegation of these powers to the author. Once such power has been expressly reserved for the author of the trust only then he can exercise the same as per clause (b).

In the case of a non-testamentary trust, the only way to expressly reserve or vest such powers of revocation to the settlor / author is by way of expressly mentioning the same as part of the instrument of the trust or in other words, the trust deed.

If any trust deed expressly gives or vests such powers in the hands of the author of the trust, then such a trust would satisfy the condition of clause (b) of section 78. It is important to note here that vesting of power would be the triggering event to classify the trust as a revocable trust. In other words, if the power is vested in the hands of the author, then the trust would be classified as a revocable trust irrespective of whether the author exercises this power or no.

To conclude, if any trust deed expressly vests the power of revocation in hands of the author of the trust, then such a trust can be termed as a revocable trust. In absence of such express powers, a trust would always be an irrevocable trust.

Needless to mention, be it a revocable trust or an irrevocable trust, for a private trust to be created, it is mandatory to fulfil all the conditions of section 6 of the Indian Trust Act. The only differentiation for a trust to be revocable in nature is the express vesting of powers of revocation to the author of the trust as part of the trust deed.

Practical Case Analysis:

It would be worthwhile to discuss the following case, which we may regularly come across while dealing with private family trust of HNI families. Analyzing this case would help the readers to better appreciate the legal insights discussed above in this article. Let us take an example to understand this.

Ram is a high net worth individual. He is married to Sita. They have two kids Luv and Kush. The family wealth is distributed between Ram and Sita. Ram settles a family trust. He appoints a corporate trusteeship service provider to act as a Trustee in this trust. All the four family members that is Ram, Sita, Luv and Kush are admitted as the beneficiaries of the trust. This has been set up as a discretionary trust. During the life cycle of the trust, Ram and Sita continue to contribute assets to the trust. As part of the trust deed, there is no express reservation of powers in the hands of Ram to revoke this trust.

Let us examine, whether the trust settled by Ram would be classified as a revocable trust or an irrevocable trust.

One line of thinking:

Ram and Sita are going to contribute assets to the trust during its lifecycle. Further, Ram and Sita have also been admitted as beneficiaries in the trust.
This is a discretionary trust wherein the beneficial ownership percentage of each of the beneficiaries has not been determined yet. At the opportune time in future, the trustee would determine the beneficial ownership of each of the beneficiaries.
So, in future if the trustees distribute the entire wealth or corpus of the trust in favor of Ram and Sita, then, in effect Ram and Sita would have reacquired their own assets. Such a situation of reacquisition of assets, might lead us to believe that this trust should be termed as a revocable trust.
In fact, the general dictionary meaning of the term revocable also meekly suggests in this direction.

Second line of thinking:

Section 78 does not lay any restriction on the settlor or contributor of assets from becoming a beneficiary in the same trust.
In fact, the definition of trust under section 3 clearly states that a trust can be settled either for a benefit of another person OR for the benefit of self and another person. Thus, the trust act permits the settlor / author to also be one of the beneficiaries.
As per clause (b) of section 78, if there are any express powers reserved for the settlor or author of the trust to revoke the trust as part of the trust deed, then it can be classified as a revocable trust.
Further, clause (b) of section 78 does not envisage any indirect situation in which the assets move back to the settlor for the purpose of classifying it as a revocable trust.
In our case there is no such powers reserved for Ram as part of the trust deed. Thus, this should be an irrevocable trust.

Comments of the Author:

The current study done in this article is restricted to the interpretation of provisions of Indian Trust Act. Considering this limited scope, we would go with the second line of thinking. In other words, we believe that the trust set up by Ram would be classified as an irrevocable trust. However, for the benefit of the readers, we would like to state that the tests and conditions laid down for classification as revocable trust or an irrevocable trust under the Income Tax Act is much wider than the section 78 of Indian Trust Act. Here, our conclusion is only restricted to the interpretation of Indian Trust Act. We would shortly be publishing another article to discuss about the implications of Income Tax Act on the classification of trust into revocable or irrevocable in nature.

Conclusion:

The issue of classification of a trust as a revocable or an irrevocable in nature has always been confusing. By way of this article, we have tried to simplify this classification as far as the provisions of Indian Trust Act is concerned.

Though, classification of a private trust into revocable or irrevocable in nature cannot be done by relying on the Indian Trust Act in silos. Even provisions of the Income Tax Act or any other commercial law that deals with the subject would have to be factored in. Stay tuned for our next article that would discuss a detailed study on how to classify a trust as revocable or irrevocable in nature as far as the Income Tax Act is concerned.

Thank You